Morning Report: Administration proposes to privatize the GSEs

Vital Statistics:

			Last	Change
S&P futures			2767	14
Eurostoxx index			384.04	3.19
Oil (WTI)			67.44	1.9
10 Year Government Bond Yield				2.92%
30 Year fixed rate mortgage				4.57%

Stocks are higher on no real news. Bonds and MBS are flat.

The Trump administration released a set of principles around privatizing the GSEs. It is more or less the same thing as before - the goal is to lessen the government's footprint in the mortgage market. The idea would be to have Fannie and Fred issue MBS with a catstrophic government guarantee - in other words, some private mortgage insurer would bear the initial losses and the government would only step in if the losses exceeded that number. That is all well and good, however there are all sorts of issues that remain before private label MBS can do the heavy lifting of the mortgage market. 

First and foremost, there is a huge gulf between what the MBS investor market requires as a rate of return and current mortgage rates. In a perfect world, PL MBS would trade at similar levels to Fannie / Freddie MBS, but they won't. There are huge governance issues that need to be resolved. For just one example, will the servicer (who is probably the issuer, who may also have a second lien) service the loan to benefit the MBS holder or themselves? What about reps and warranties? I went into more depth about this whole issue here. These uncertainties need to be priced in, which means that the bid / ask spread between private label and FNMA MBS is so large that nobody would take out a mortgage at the rate the private label investors require. That is a necessary but not sufficient requirement to bring back private money into the US mortgage market. 

Taking the GSEs out of conservatorship is going to require legislation, and to be honest it isn't a priority for either party. As far as DC is concerned, yes it would be nice if the government could lessen its footprint in the mortgage market, but people are getting loans, and the market is functioning normally. It just isn't a priority. 

The US borrower believes that the 30 year fixed rate mortgage is nothing unusual. In fact, it is a distinctly American phenomenon, where the borrower bears no risk. In the rest of the world, mortgages are adjustable rate, and not guaranteed by the government. In other words, the borrower bears the interest rate risk and the bank bears the credit risk. In the US, the bank bears the interest rate risk and the taxpayer bears the credit risk. Upsetting that apple cart is going to be a tough slog politically. 

Finally, the news did nothing for the stocks of Fannie and Fred, which continue to languish. When the government took over Fannie and Fred, they left 20% of the common outstanding. This was an accounting gimmick to prevent the government from having to consolidate Fan and Fred debt on its balance sheet (incidentally, this was the reason why LBJ privatized the GSEs in the first place). The government could not take the GSEs through a bankruptcy without creating chaos in the mortgage market. So they left 20% outstanding and decided to deal with the bankruptcy part later. The stock should be worthless, but it is a litigation lottery ticket.

A Federal Judge ruled yesterday that the CFPB's structure is unconstitutional. The PHH case never made it to SCOTUS, but it will be interesting if this one does. At some point, the CFPBs structure will make it to SCOTUS, and the only one with the standing to defend the agency is the government.